Celestin Pepin is a CFA charterholder with significant experience investing in alternative assets. This article will look at the ever-increasing popularity of alternative assets structures, which are helping investors to reach their long-term goals and are backed by multi-layered risk management, extensive global resources, and a research-driven investment approach.
Alternative investments are financial assets that do not fall into one of the conventional asset categories such as stocks, bonds, exchange traded funds, or mutual funds. Common examples of alternative investments include hedge funds, private equity, venture capital, commodities, arts and antiques, managed futures, and derivative contracts. Real estate is sometimes classified as an alternative asset.
Less tightly regulated by the U.S. Securities and Exchange Commission, alternative assets tend to be somewhat illiquid. While traditionally geared towards accredited or institutional investors, alternative investments have become available to retail investors via alternative funds. Cryptocurrency, collectibles, and commodities are all common forms of alternative investment.
Alternative assets are usually held by institutional investors or accredited high-net-worth individuals. They are complex by nature, lacking regulation and therefore attracting a high degree of risk. Many have high minimum investment thresholds and fee structures, particularly when compared with exchange traded funds and mutual funds. With alternative investments, there tend to be fewer opportunities to advertise to the public and publish verifiable performance data. Although alternative assets often incur high upfront investment fees and initial minimums, transaction costs are generally lower than those of conventional assets due to their more modest levels of turnover.
Compared with their conventional counterparts, most alternative assets are fairly illiquid. Take for example an 80-year-old bottle of cognac, which will be far more challenging to sell than 1,000 shares in Google due to the limited number of prospective buyers. Investors may also have difficulty valuing alternative investments, as this type of asset and transactions involving them are often rare. For example, valuing antiquities is incredibly challenging when there are no recorded instances of similar specimens changing hands.
Commodities, i.e. raw materials such as precious metals and oil, are a popular form of alternative investment, enabling investors to own tangible assets with real-world uses and perpetual demand due to their underlying characteristics. A prime example is gold, which benefits from enhanced price stability due to ever-increasing demand from a wide range of industries combined with its role as a store of value.
In addition to physical properties, investing in real estate can also include property-based securities, real estate investment trusts, real estate crowdfunding platforms, and real estate mutual funds. Investors in this type of alternative asset benefit from a stable stream of cashflow in the form of operating income, as well as capital appreciation of tangible assets.
Cryptocurrency is the emerging form of digital currency, having gained huge popularity as an alternative investment outside of the traditional scope of stocks and bonds. Other common forms of alternative investment include art and collectibles; venture capital or private equity stakes; and peer-to-peer lending.
Even for experienced investors, incorporating alternative assets into their investment portfolio can be challenging, requiring careful consideration of risk tolerance, the investment timeframe, and the investor’s level of comfort in terms of illiquidity. Typically requiring a commitment over the medium- to long-term, alternative investments also offer significant potential benefits, with the low correlation of alternative assets within traditional markets providing valuable diversification and reducing portfolio volatility. When managed skillfully, the illiquidity premiums inherent to private markets translate to higher return potential.
Banks and other financial institutions are increasing access to alternative investments, presenting their clients with a wider range of diversification options, as well as providing them with a substantial new revenue stream in some instances. Alternative assets such as real estate and private equity diverge from the patterns of traditional listed markets, presenting a potential hedge against negative market trends and the potential for higher returns.
